Here are some hypothetical numbers used to illustrate the ideas of trade-offs, s

Question

Here are some hypothetical numbers used to illustrate the ideas of trade-offs, specialization, and comparative advantage. Assume Sri Lanka, using all her resources efficiently, can produce either 1,000 bags of rice OR 3,000 bags of tea. Let's also assume that, using all her resources efficiently, Kenya can produce either 1,000 bags of rice OR 1,000 bags of tea. Further, assume that the countries have similar resource endowments and that, initially, they are not trading with each other. Therefore, each of the countries has to produce both rice and tea for its citizens. Suppose that, in the no-trade situation, Sri Lanka was consuming 400 bags of rice and 1,800 bags of tea, and in the no-trade situation, Kenya was consuming 500 bags of rice and 500 bags of tea. Now, let's play a fun game called the "Trading Game" to figure out whether there is any benefit (in terms of increased consumption possibilities) for these two countries if they trade with each other. You are given the following information to start the "Trading Game". The trading price is set at one bag of rice for two bags of tea, and Kenya wishes to keep at least 550 bags of rice after trade.

Now, let's play a fun game called the "Trading Game" to figure out whether there is any benefit (in terms of increased consumption possibilities) for these two countries if they trade with each other. You are given the following information to start the "Trading Game". The trading price is set at one bag of rice for two bags of tea, and Kenya wishes to keep at least 550 bags of rice after trade.

Apply your knowledge of opportunity cost to identify the comparative advantage enjoyed by each country. Now using your knowledge of specialization and trade, show in a multi-paragraph essay, that the two countries can benefit by consuming more of both goods after trade.

Explanation / Answer

Opportunity Cost and Comparative Advantage

Sri Lanka produces either 1,000 bags of rice or 3,000 bags of tea. Kenya produces either 1,000 bags of rice or 1,000 bags of tea. Both countries are using all of their resources efficiently and in the present time, are not trading with each other. In a no-trade situation, countries have their own production possibilities frontier, or PPF. Since Sri Lanka and Kenya are both using their resources efficiently, they are producing efficiently at a point on their PPF. However, if the two countries decided to trade with each other, they have the potential to benefit, in terms of increased consumption possibilities, if a comparative advantage can be found, in which each country could specialize and then trade. When this happens, each countries production point remains on the PPF, but their consumption point can now move outside the PPF.

In order to see if the two countries could benefit from trading with each other, you first have to find both countries

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